FINANCIAL STABILITY AND ECONOMIC

STIMULUS PACKAGE.
Prof. S. Moharana
Director MFC,
Department of Commerce
Utkal University
Financial Stability is considered to be the prime requisite for the accelerated and
sustained economic development of a nation. The period from 2006-07 to 2008-09 was
marked by the global financial instability of a magnitude not noticed since the 1930’s great
depression. The financial meltdown which started in the developed economies of the world
led by USA spreaded its tentacles to the developing and under developed economies. Indian
economy experienced some amount of financial and economic instability including lower
economic growth rate during the initial two years but due to a conservative economic policy
of the government and comparatively lesser dependence of the real sector of the economy on
the external market, the adverse impact did not continue for a long time.

No welfare government can afford to allow the financial instability to continue for a
long time. The financial instability at the macro level leads to bank runs and banking panics,
security market instability, price level instability, currency instability, house hold debt crisis,
corporate financial crisis and in extreme case sovereign debt crisis. There are cases when
financial instability also leads to political instability. The greater the size of the economy,
higher will be the destabilising impact of financial instability. The higher the linkage of the
domestic economy with the global economy, faster will be the pace at which the financial
crisis will spread from one sector to another and from one economy to another.

Financial instability when accompanies by real sector crisis becomes very difficult to
control. The traditional fire fighting tools available with the government, namely the
monetary and fiscal policy instruments have always proved to be ineffective. The approach
needs to be an integrated one with the combination of monetary policy, fiscal policy and trade
related measures. More important is the innovation and non conventional approach to fight
the economic crisis.
 In the aftermath of the global financial crisis, like most other countries of the world,
Indian government also announced a number of measures to shield the economy from the
global crisis and to minimise its adverse impact. One type of measures was intended toward
ensuring adequate liquidity in the economy. This includes the reduction in CRR, repo rate,
etc which led to huge increases in the liquidity in the system. The second type of measures
includes reduction in the Cenvat (from 14% to 8%) and Service tax (from 10% to 8%), which
were aimed at the making production less costly and marketing move competitive in the
recession affected world. The Government also increased its planned expenditures on
different heads to improve the infrastructural facilities and more importantly increase the
purchasing power in the hands of the consumer.

The total cost of the economic stimulus packages is estimated at more than Rs. 4 Lakh
Crores accounting for nearly 3 pc of the GDP. The fiscal deficit went up from 2.5pc of GDP
in 2007-08 to around 6.8pc during 2009-10 which is the highest in the last 16 year. The Govt
had a target of borrowing Rs 4.9 Lakh Crores during 2009-10 of which 85% is already
exhausted till the first week of January 2010. The crowding out effect of huge Government.
Borrowing has increased the cost of funds for the private corporate sector leading to slow
down of the investment activities. It also increased the yield on Govt. Bonds which has gone
up to 8pc by January 2010 end. The inflation is already at a record high level. The higher
inflation weakens the currency and depresses the growth. The persistent high borrowing of
Government has increased the debt servicing obligation. During 2009-10, the interest
payment as a percentage of revenue receipt is as high as 36.7pc. A higher interest burden eats
up a large portion of Govt. Revenues leaving less for productive expenditure.

Just before the presentation of budget in the parliament on 27th of February, there is
increased debate going on in the intellectual circle both in the print and visual media, whether
it is advisable for the Govt. to withdraw the economic stimulus package announced at
different stages which has resulted in huge loss of revenue for the government.

There are apprehensions in the minds of the economists and policy makers that
immediate withdrawal of stimulus package will lead to a severe blow to the slow revival
process that is already noticed in the economy. The Government is in a catch 22 situation. If
the economic stimulus package is allowed to continue, fiscal consolidation which is so
important for economic and financial stability will be difficult to achieve. Further, the
government cannot allow it to continue due to its adverse impact on the revenue side, Govt.
Borrowings and on fiscal deficit.

While any abrupt withdrawal of the package is not advisable, a gradual withdrawal
will always be in the greater interest of the economy. It is my personal belief that to make the
Indian Corporate sector competitive in the international economy, the Govt. Should go in for
phased withdrawal of the economic stimulus package. The continuance of the package for a
long period will lead to a dependency syndrome among the corporate sector. This was very
much apparent during the period of controlled and regulated economic regime in India in the
pre liberalisation period.

At present, there is a positive trend in the growth rate of government revenue, exports,
imports, outputs both in .manufacturing sector as also in the services sector. Due to arbitrage,
huge amount of foreign investment is flowing to Indian economy prompting the RBI
Governor to indicate the possibility of imposing capital control. In the near future,
Government may also go for selected disinvestment in PSU’s and 3G auction which will
result in a significant increase in the revenue and lowering of fiscal deficit. The health of the
banking sector in India can be considered to be very sound in spite of the requirement of
more capital to shore up their capital base. Not a single bank needed bail out support from the
Government. The security market is showing signs of stability. The investment activity is
slowly getting revived. The only concern for the Government is huge liquidity in the system
both in the banking sector also in the corporate sector. The Corporate are not taking any
aggressive steps for capital investment waiting for more stability in the domestic and global
market. The price level instability is posing the greatest .threat to the Government. The
increase in commodity prices is something which does not have a short term solution. The
general trend in the prices at the global market, increasing demand from consumers and a
near stagnancy in growth of domestic production in agriculture might have contributed to this
crisis. It needs a long tern approach and it is in the interest of the Government to seriously
look at this problem.

To conclude, I strongly feel that Govt. should withdraw the economic stimulus
package in a phased manner by closely monitoring its impact on the economy. It is possible
that the withdrawal may invite oppositions from industrialists and so called welfare
economists. But this is a cost which we need to bear to enable the long term sustainability of
the economic growth and to achieve a healthy and efficient financial system.